How Offshoring Can Affect the Industries’ Skill Composition

Figure 1: Labor Market Effects of Offshoring - The Sector Bias

equilibrium, production takes place at points A and B, where the unit value isoquants
Q interact with the relative price line wL/wH. The Y industry produces at point B with
the use of two intermediate products YH (relative high skill intensive) and YL (relative
low skill intensive).

Now suppose that, e.g. due to advances in technology and communication, off-
shoring gets possible and that the low skill intensive industry (e.g. the import com-
peting one in a high skill abundant economy) relocates production of its relative low
skill intensive intermediate abroad and imports the respective input instead. Thus, do-
mestic production of Y consists solely of production of the relative high skill intensive
component YH . At the initial relative wage ratio, factor intensity in the Y industry shifts
to the more high skill intensive expansion path YH (let’s call this the "offshoring-effect").
While the relative price of Y remained unchanged, overall costs decrease due to the
lower-cost procurement of the foreign country, shifting the unit isoquant inward to
Q^‘_Y . However, due to this decrease in costs, the unchanged relative price of Y is now
inconsistent with the initial relative wage ratio. Therefore, Y producers increase the
relative demand for low skilled labor (since it is the relative low skill intensive indus-
try). Relative wages of the low skilled increase as long as the new ratio is tangent to
the new isoquant Q^‘_Y, resulting in the new equilibrium of production at A^‘ and B^‘ (let’s
call this the "wage-effect"). As can be seen with the new expansion paths X^‘ and Y^‘, the
combination of the "offshoring-effect" and the "wage-effect" induces skill shifts in both
industries towards more high skill intensive production patterns. The framework can

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